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Inequality and economics: let’s go back to Adam Smith

Although the issue of economic inequality has long been neglected by economists, it has become increasingly important in academic and public debate over the past decade, as evidenced by the success of books by Piketty (Capital in the Twenty-First Century and Capital and Ideology), Atkinson (Inequality. What can be done?) or Milanovic (Global Inequality: A New Approach for the Age of Globalization). In addition, international institutions long considered pro-liberal, such as the OECD and the IMF, are now openly calling on governments to take redistributive and tax justice measures to enable more inclusive and equitable growth.

The reason for this recent and growing interest of economists in the issue of inequality is mainly due to the progress made in measuring inequality, but also and above all to the increase in inequality since the 1980s-1990s, which has been more or less significant depending on the country, combined with a slowdown in growth, particularly in the advanced countries. And the current global crisis of COVID-19 is likely to accentuate this phenomenon, since it has plunged many economies into recession and exacerbated inequalities within nations. Hence the numerous calls for exceptional wealth taxation to finance measures to support the economy and the resulting increase in public debt. The first tax measures announced by the Biden administration (increase in the corporate tax, the top marginal income tax rate and the taxation of capital income) and its willingness to implement a minimum corporate tax rate are aimed at reducing inequality and restoring tax justice in the US.

But why have economists long neglected the issue of economic inequality? While not exhaustive, we can identify three main reasons or beliefs (myths?) shared by a large number of economists. Firstly, the belief in the inverted U-shaped Kuznets curve, which tells us that inequality tends to increase in the first phase of a nation’s development and then decreases, which is now clearly contradicted by the facts. Secondly, the belief in trickle-down economics, i.e. that the enrichment of the richest will ultimately benefit the poorest, which has never been empirically proven. Finally, the belief that there is necessarily a trade-off between efficiency and equity, with the priority of economists being to determine how to achieve the former, by maximising wealth creation.

The latter two beliefs have a long history, and it is tempting to trace them back to the man generally regarded as the founding father of economics, Adam Smith. Indeed, Smith would have focused on how to maximise social wealth, the growth of which would benefit everyone, especially the poorest. Smith would have emphasised the benefits of economic growth in reducing absolute poverty, without regard to inequality as such, and he would have argued against state redistribution.

In fact, Smith took the issue of economic inequalities, which were very important in his time, quite seriously. But it should be noted at the outset that Smith, like all classical economists, was interested in the functional distribution of income rather than the interpersonal distribution, i.e. essentially the differences in income between the three social classes of workers, landowners and capitalists. The most recent estimates show a Gini index for incomes in Britain in the second half of the 18th century of over 0.5 and rising (compared to around 0.35 today). Moreover, it is estimated that the gap between the average income of workers and aristocrats was about 1 to 33, and 1 to 11 on average with capitalists. That said, Smith seemed more interested in the causes of inequality than in its level as such and emphasised the harmful consequences that inequality can have on the morality and happiness of individuals and nations. He also and above all sought to determine what are just and unjust inequalities and to reconcile efficiency and equity, rather than to oppose them. And contrary to what one might suppose, he also argued in favour of a (slightly) progressive tax system, at a time and in a nascent discipline when this position was very rare. Thus, not only should Smith not be held responsible for the lack of interest economists have long shown in the issue of inequality, but he can still enlighten us on this issue today.

Recent Comments

  1. Wyn Achenbaum

    Perhaps more relevant today, particularly to the issues of inequality, than Adam Smith are the writings of Henry George, who read Smith closely and recognized some things that were not visible to Smith. “Progress and Poverty” (1879) is a great read!

  2. Constantinos Ragazas

    Extreme Economic Inequality leads to Social, Political and Economic instability. And therefore Economic inefficiency of the highest order.

    To have well functioning economies we need to have a large middle class. And consider the Consumer as an essencial key component of any economy. Without which no economy can exist!

    The essential “job” of the Consumer for any Economy has “economic value”! And needs to be recognized and rewarded in the form of Quaranteed Universal Minimum Income!

    Which can itself be used to regulate the Economy at times of Recession and Inflation. Or at times of national and global emergencies. Like the Covid pandemic and looming Climate Change disruptions.

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